This text has been translated from Norwegian with the assistance of GPT UiO.
— Climate risk for finance is about the possibility that financial assets are devalued because of climate change, says Stine Engen.
She recently defended her doctoral thesis at the Centre for Technology, Innovation and Culture (TIK), University of Oslo. There, she examined how finance manages climate risk and traced some of its practical consequences.
Defining speech
According to Engen, the concept of climate risk became more widely known in the financial sector in 2015, when the then Governor of the Bank of England, Mark Carney, gave a widely discussed speech. In it, Carney argued that climate change could become the next major financial crisis if finance did not start factoring it into its models. He divided climate risk into two subcategories:
One is financial risk resulting from physical climate change, such as floods, heatwaves and other weather events that can destroy buildings, infrastructure, agriculture and more.
The other he called “transition risk”. This concerns financial risk arising from the shift to a more environmentally friendly, lower?carbon society. New government regulations are assumed to follow, which may particularly affect carbon?intensive sectors, but also create societal needs for entirely different goods and services.
— Transition risk encompasses both consumer demand and, to a large extent, government regulation that will affect companies and their financial values. All these things represent financial risk in the world of finance, Engen notes.
Stimulating the green transition
She explains that the climate risk concept was developed in the early 2010s by both financial actors and climate policy actors who were trying to mobilise the financial sector to invest more in the green transition.
— By framing climate risk as a potential loss of value, the aim was to encourage the financial sector to move its money from high?risk investments to lower?risk ones and thereby finance the green shift.
Public communication about climate risk can thus be seen as a strategy to make carbon?intensive investments financially risky by questioning their future value, she explains.
This differs from the more common way the state has tried to attract private investors to green projects, Engen says—namely by removing financial risk from such projects and stepping in with subsidies as needed.
— If you need funding for a wind farm and investors are hesitant, the state can step in with subsidies and make the investment more attractive.
She stresses that, by contrast, the climate risk concept seeks to instil the idea that carbon assets are risky because they will have little or no value in future, and that it therefore makes sense to shift investment in a greener direction.
Which risk?
By looking more closely at how climate change and climate policy are translated into financial risk, she shows that this can have unintended consequences—among other things because finance operates with a different notion of risk. In financial terms, Engen points out, risk is not simply a threat but also a possibility for return.
— In finance, people talk about “high risk, high reward”. If there is high risk, there may also be high returns, which implies a very different understanding of risk from everyday usage, where risk primarily refers to danger.
For that reason, Engen has looked at high?emission companies.
— Even if there is an attempt to make high?emission companies riskier investments, that does not necessarily mean they are poor investments in a financial sense, she says.
— If these companies are also good at managing financial risk, they can in fact be good investments.
This happens particularly because many financial actors do not primarily model the financial risks associated with climate change itself, Engen emphasises, but rather the financial risk arising from climate policy.
The paradox
— I find it interesting to consider what view of politics this implies. Instead of doing what one could call direct policy via regulation, there is an attempt to do climate policy through financial risk, and that creates a rather odd relationship between politics and the governance of financial risk, she says.
On the one hand, financial actors are expected to enact climate policy indirectly by factoring climate change into their calculations. On the other hand, Engen notes, finance models the likelihood that climate policy will be implemented.
— Politicians want financial markets to shift capital towards greener investments. But the way this is supposed to happen is by anticipating the climate policy that is coming. At the same time, it is said that climate policy as a whole depends on that capital being moved, Engen explains, adding:
— If financial actors, for example, do not believe the Paris Agreement will materialise, then in a sense there is no financial risk either.